Posts Tagged ‘economics’

There are some words that when you hear them you just want to say, “Wow! What a good word.” Disintermediation is one of those words. It came into use in the late 60s and then languished in obscurity until it experienced a Renaissance during the dot com boom in the late 90s. In its new incarnation it took on the generic meaning of removing the middle man from transactions. If you have a higher standard of living now than you did 20 years ago this is one of the words you have to thank.

Disintermediation is one of the hallmarks of the internet revolution. It has caused amazing effects on society along with other socioeconomic phenomenon such as improved logistics, commoditisation of goods leading to effective marginal costs of zero, and instant information. My view is that these byproducts of technical growth are all interrelated, have vastly improved our standard of living, and have some frightening implications for economic cycles.

Moore’s Law has the effect of giving us ever faster computers at ever lower costs. But it was the internet that precipitated an inflection point in society. Before the internet we had telecommunications. Businesses leveraged their computing resources by connecting locations point-to-point. There were exceptions, but fast data transfer was non-existent and slow data transfer was expensive.

The internet turned this on its head. Suddenly anyone could connect to anyone. Data transfer was relatively cheap. Bit rates exploded. Better communication led to better logistics. Data transfer itself became a commodity. Information became instantly available, anywhere. And disintermediation came into its own.

New electronic exchanges popped up, improving existing exchanges or replacing traditional wholesalers. Ebay savaged newspaper revenue models by making classifieds old fashioned and slow in comparison. Amazon did not so much cut the middle man out as replace the traditional bookstore. Online brokerage firms skimmed knowledgeable investors from traditional houses and opened up trading to a whole new class of people.

In all of these cases disintermediation improved the velocity of transactions. They occurred faster and with less cost than by traditional methods. One of the general effects of reduced costs though are reduced margins, in absolute terms if not also in relative terms. To survive companies must compensate by having greater sales volume. A traditional book seller may make $1 on a book. Amazon may make $.05. Amazon is going to sell a bazillion of them though because consumers can save $.95 by buying from Amazon.

I would guess that Amazon is responsible for increasing the overall market for books. But still, that market pie has to be divided up. Because Amazon tends to be more efficient and cheaper than a bricks and mortar store it has fundamentally changed the market place and many less efficient retailers have gone out of business or altered their business models. Barnes & Nobles has both invested in online distribution and closed physical outlets. This is representative of many industries: fewer, more efficient players and lower margins.

The benefits are obvious: lower costs. But are there negative implications for society? In many industries there has been a proliferation of smaller players serving niche markets, many that were probably underserved prior to the internet. However, in many industries, particularly those selling real goods there has been consolidation of vendors. Lower margins and higher volume means that fewer players can survive. This can mean less choice for consumers. The real effect has been a greater scarcity of specialty goods in retail outlets at “reasonable” prices.

MegaMart sells a can of tomatoes $.15 cheaper than any of its competitors, but it does not carry your favorite specialty item. Pop’s, who used to carry that specialty item that you bought twice a year has gone out of business because everyone buys their commodities at MegaMart. Pop’s cannot match MegaMart’s commodity prices and it cannot charge enough on specialty items to survive. Your specialty item can probably be found online somewhere, but it will cost you dearly.

As a further consequence since your specialty item is now only available online fewer people see it. It may be available to 330 million people in the United States, but that does not mean that they will see it. And even if they do see it, will they buy it? You might be willing to take a chance on a new item or choose it as a substitute while standing in the grocery isle, but will you be as adventurous while surfing the internet? I think probably not and the market for your specialty item shrinks again, leading to less variety in the marketplace.

Economies fluctuate between growth and recession. Ideally the growth part of the curve tends to be greater than the recession part. I predict larger fluctuations occurring at more frequent intervals or bigger recessions more often. The big cause of this is disintermediation. But disintermediation has been one of the driving factors of growth over the last 10 years. How could it make recessions worse or cause them to occur more often?

Disintermediation has accelerated our growth by removing the fat from our institutions. It has made them more efficient. That efficiency has a side effect though. Removing the fat has reduced buffering capacity. The term comes from chemistry. In general it is the ability of a system to absorb change without it causing a significant fluctuation in the system. As inefficiencies are removed from economic systems it makes them more vulnerable to smaller changes and more likely to react more violently.

Consider the town of 30 years ago. The mom and pop stores may have had a profit margin of 20%. If they have a bad year they hold off on buying that new car. They stay in business and just tighten the belt a little. What about now? That same store may be operating with a margin of 8%. They were not going to be able to buy a new car anyway. If they have a bad year, they are out of business. There is just less fat, less inefficiency, less buffering capacity in the system now. Smaller changes in initial conditions effect larger changes on the system. Fluctuations occur more often and at a faster pace.

Disintermediation. It has brought us growth and a higher standard of living. But, I assert that it has brought us less effective choice in our selection of daily consumables and will contribute to deeper recessions, more often. I do not like to be wrong. In this case I hope I am shown to be a fool.